Archive for August, 2012|Monthly archive page

I’ll admit it. I’m a mark for Capra films. I cheer for every ulcer Grandpa gives the IRS agent. I cry every Christmas Eve when Clarence gets his wings. And like Mr. Smith, I’ve always wanted to go to Washington and tell ’em what’s what. Sadly, the opportunity rarely arises.

However, a few brave California tax attorneys courageously face the DC humidity every summer to do that which I only dream: tell the IRS and Congress how to better administer taxes. It’s as sexy as it sounds.

This past May, the taxation section of California State Bar sent its annual Washington, DC delegation to our nation’s capital to discuss current tax issues with Treasury officials, congressmen, and other policy-makers. Their reports were just published, which included the following recommendations relating to international tax issues:

Jenna Shih, Esq. and CPA Po Han Chen recommended that regulations be issued clarifying the rules to determine whether a US-owned foreign company may be treated as engaged in the active business of developing its own intellectual property (and therefore escape US taxation on its profits). The authors noted that current case law allows such treatment where the company’s direct employees manage the business, even if independent contractors develop the IP.

In particular, the authors noted that participation in Mexican retirement funds represents a low-risk of tax evasion because such pensions are not created to allow foreign investment, but are actually part of a mandatory condition of Mexican employment.

Finally, Patrick W. Martin and Liliana Menzie proposed expanding the FATCA definition of “local foreign financial institutions” to ease compliance burdens for foreign banks whose clients are considered “accidental Americans” (i.e. individuals who live in other countries but retain U.S. citizenship).

If you have any interest in preparing a report or a recommendation for next year’s delegation, click here for more information, or contact me and I can put you in touch with one of the organizers.

Well, in 1976, Congress sought to deter participation in non-U.S.-sanctioned boycotts by the imposition of the tax penalties codified at Code Section 999.

Generally speaking, the section features two parts: the risk of losing certain income tax benefits from boycott participation and (surprise!) a reporting requirement.

Taxpayers who actually participate in a boycott risk losing certain foreign tax credit and DISC benefits, increasing their Subpart F income, and may be fined.

But what about that reporting requirement? That rule is surprisingly broad. If a taxpayer has operations in or related to a boycotting country and that country is on the above-mentioned list, those operations must be reported. And by “operations,” Treasury really means “any meaningful commercial contact.” Also, a taxpayer must report any operations in a non-listed country when the taxpayer “has reason to know” that participation in or cooperation with an international boycott is a condition of such activities. Needless to say, this “has reason to know” qualifier greatly expands the world of potentially reportable transactions well beyond the Middle Eastern countries listed above. Failure to report could subject a taxpayer to a fine of $25,000 plus a year in jail.

Iraq’s re-emergence on the list is notable, given that it had been removed as recently as August, 2010. Other notable “alumni” include Bahrain and Oman.

While not as onerous as an FBAR report, or as frightening as the looming FATCA requirements, the Section 999 reporting requirement should not be ignored. The generality with which it may be applied makes it a dangerous IRS weapon, even if rarely wielded.

Although a “fly-over,” Kansas is indeed an actual state. On August 15, the Tenth Circuit affirmed the Tax Court’s holdings denying an individual’s arguments that he was a “a citizen of Kansas that earned a living through activities occurring solely under the jurisdiction of Kansas” and therefore not a federal taxpayer; and that he did not receive taxable income.

Hmmmmm . . . This sounds familiar. This kind of argument, with its hints of facial logic (“Citizen of California? Makes sense to me!”) are very popular with the tax protest movement and very likely to get a proponent sanctioned. In dismissing the taxpayer’s claim, the panel also mentioned the following similarly facetious anti-tax arguments:

“the authority of the United States is confined to the District of Columbia,”

“wages are not income,”

“the income tax is voluntary,”

“no statutory authority exists for imposing an income tax on individuals,” and

“individuals are not required to file tax returns fully reporting their income”

Quick rule of thumb for heavily-promoted tax dodges: if Mitt Romney isn’t doing it, it’s likely not legal. The full opinion can be found here.

Chief among its new additions is a new enhanced “line 4” that features no less than 21 options for an entity to choose from when indicating its FATCA status designation and five extra pages relating to that choice. Accompanying instructions and regulations have not yet been issued.

This is what we call “tax simplification.”

IRS Hails Whistleblowers As part of an American Bar Association Section of Taxation webcast, IRS special trial attorney and division counsel John McDougal noted the utility of the Service’s whistleblower program. According to McDougal, whistleblower data constitutes one of the most important sources of taxpayer information for enforcement efforts. McDougal noted the IRS has just recently begun to distribute award payments to individuals who have supplied that information. Because whistleblowers often present information on a particular financial institution or practice, the IRS is able to gain access to information outside the U.S. that is not otherwise easily available. “It’s an incredibly valuable opportunity for us,” McDougal said.

The mainstream media (first time I’ve ever used that term this election cycle!) often portrays the use of foreign business entities as an arcane, indecipherable tax-dodging practice available only to huge corporations and the very wealthy.

The truth is far more mundane and, therefore, relevant to growing middle-market and closely-held businesses.

Take, for example, this past Tuesday’s re-issuance of a May 15, 2012 decision by the Michigan Court of Appeals. In Wheeler v. MI Dept. of Treasury, the court held that the shareholders of a domestic S-corporation were entitled to combine that corporation’s income with that of its subsidiary foreign partnerships when determining how to properly apportion state income tax liability.

So what does all that mean?

How Multi-State Allocation Works

Like many states, Michigan relies on statutory rules of allocation to determine which income from out-of-state activities are not subject to Michigan income taxes. Some taxpayers can easily identify out-of-state activities and thereby allocate their income to specific geographic areas. Others often encounter difficulties attempting to make such an allocation. States are allowed to tax these multi-state operators on an apportionable share of their multistate business attributable to their jurisdiction. This is known as the “Unitary Business Principle” (or “UBP”) and is often expressed within a state’s revenue statutes in the form of a formula that accounts for factors such as the taxpayer’s in-state property, payroll and sales.

In Wheeler, the taxpayers were the individual owners of a Michigan S Corporation with underlying foreign subsidiaries that were also transparent for tax purposes. The owners treated their income from all their domestic and foreign pass-through entities as a unitary business and included in their UBP apportionment calculation the factors attributable to their foreign entities, resulting in a lower Michigan tax bill. Michigan argued that UBP did not allow consideration of the foreign entities’ activities.

The Decision

In holding for the taxpayers, the court noted that “the plain language of the [statute] requires unitary, international businesses to apportion their income, and the plain language of the [statute] in effect during the years at issue required unitary, international businesses to include international apportionment factors in the calculation of property, payroll, and sales factors. . . . [T]herefore, we enforce the statute as written and follow the plain meaning of the statutory language.”

The Takeaway

When you or your clients plan for next year’s anticipated total tax obligations, don’t automatically assume that international operations are entirely separate from domestic. You might be leaving money on the table if you don’t examine a full unitary approach for all your operations.

In today’s brave new world, even the smallest company often finds itself a player in the global economy. In today’s brave new world, even the smallest company often finds itself a player in the global economy. Whether you’re outsourcing your webpage development or shipping inventory in from overseas, international transactions ... Continue reading →